MASTER THESIS

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CHARLES UNIVERSITY IN PRAGUE Faculty of Social Sciences

Institute of Economic Studies

MASTER THESIS

2007 Bc. Lucie Svrčková

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Charles University in Prague Faculty of Social Sciences

Institute of Economic Studies

MASTER THESIS

European Cohesion Policy: Did It Succeed in Lowering of Regional Disparities?

Author: Bc. Lucie Svrčková

Supervisor: Prof. RNDr. Ing. František Turnovec, CSc.

Academic Year: 2006/2007

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Prohlašuji, že jsem diplomovou práci vypracovala samostatně a použila jsem pouze uvedené prameny a literaturu.

I do hereby declare that I have written this thesis independently and that I used only the sources listed.

Prague, 18^th May 2007 ...

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ACKNOWLEDGEMENTS:

At this place I would like to express my thanks to my consultant, Prof. RNDr.

Ing. František Turnovec, CSc., for his kind attitude and active approach, for his consultations which provided me with a worth insight into regional problematic and supplied me with a plenty of useful information and advice, and last but not least for his valuable cooperation during all the time I spent at the IES.

Sincere thanks go to all who have been close to me during my studies. Big acknowledgement belongs to my parents, for their unceasing support.

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ABSTRACT

The master thesis provides with an insight into the issue of regional problematic in the European Union. Theoretical background illustrating basic facts about institutional structure, historical development and justification for the existence of common structural policy, and further facts about possible welfare influence of this redistribution instrument, is followed by analysis of income disparities across the EU, both at the national and regional level, and their development during recent two decades. Redistributive effects of the EU regional expenditures are evaluated, in terms of the extent to which they have been aimed at weaker rather than more prosperous parts of the Community. In consequence, effectiveness of RP is examined; regression models for regional disparities try to show whether there has been a positive relationship between the EU structural resources and narrowing of averaged income gaps across the Union. My practise is slightly different from most of the empirical work on this issue as I try to explore RP effects both for particular EU countries and for the EU as a whole.

ABSTRAKT

Diplomová práce se zabývá problematikou regionálních disparit v rámci Evropské unie. Po teoretické části, kde jsou objasněny institucionální struktura, historický vývoj, opodstatnění existence regionální politiky na evropské úrovni a dále potenciální vlivy této redistribuce na blahobyt v zúčastněných oblastech, jsou zkoumány příjmové nerovnosti v jednotlivých evropských regionech (a to jak na národní úrovni, tak v rámci jednotlivých členských zemí) a jejich vývoj během posledních přibližně dvaceti let. Následuje analýza redistribučních efektů evropských strukturálních výdajů z hlediska jejich cílení na relativně nejslabší části Společenství. Pomocí lineární regrese je hodnocena efektivnost regionální politiky, konkrétně (ne)existence pozitivního vztahu mezi regionálními subvencemi a vyrovnáváním nerovností v důchodech vzhledem k průměru EU. Můj přístup je poněkud odlišný od většiny empirických studií zabývajících se těmito otázkami; snažím se prozkoumat účinnost regionální politiky jednak v jednotlivých členských státech a jednak pro Unii jako celek.

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LIST OF TABLES

Table 1: % of national population assisted by Objective I and by priority of convergence in particular RP programming periods

Table 2: Comparison of main priorities and financial instruments of cohesion policy in current and previous programming period

Table 3: GDP per capita in PPS in 1983 – 1998 (%, EU – 15 = 100%)

Table 4: Top and bottom ten regions in EU – 25 according to GDP p.c. in PPS in 2003 (%, EU – 25 = 100%)

Table 5: GDP per head in PPS in ten richest and poorest regions in the Union, 1983 and 1993 (%, EU – 15 = 100%)

Table 6: Change of regional GDP p.c. in EU – 25 between 1995 and 2003 Table 7: Gini index during the period 1995 – 2005 (%)

Table 8: Disparities in GDP per head in PPS by region within member states, 1995 – 2003, weighted standard deviation of index EU – 25 = 100

Table 9: At – risk – of – poverty rate (%)

Table 10: Comparing of redistribution from rich to poor in the EU over 1989 - 2013 Table 11: Real GDP growth rate (%) – average 1989 - 1993

Table 12: Real GDP growth rate (%) – average 1994 - 1999 Table 13: Structural aid in 1989 – 1993 (mil. ECU)

Table 14: Allocations to particular objectives during 1989 – 1993 (mil. ECU) Table 15: Structural aid in 1994 – 1999 (mil. ECU)

Table 16: Allocations to particular objectives during 1994 – 1999 (mil. ECU) Table 17: Structural aid in 2000 – 2006 (mil. €, current prices)

Table 18: Allocations to particular objectives and initiatives during 2000 - 2006 (mil. €) Table 19: Structural aid in 2007 – 2013 (mil. €, current prices, rounded)

Table 20: Effect of structural policy: simulations results, 2000 – 2006 (% difference from baseline without policy) – the Quest model

Table 21: Effect of structural policy: simulations results, 2000 – 2006 (% difference from baseline without policy) – the Hermin model

Table 22: Effect of structural policy on physical infrastructure and human capital, 1994 - 2010: Hermin simulation results (% difference from baseline without policy)

Table 23: Change in GDP, employment and productivity in Objective I regions in EU – 15 during 1994 – 2001 (annual average % change)

Table 24: Achieved results on effectiveness of structural expenditures in the thesis

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LIST OF FIGURES

Figure 1: Regions in EU – 25 under Objective I and II in period 2000 – 2006

Figure 2: Regions under priorities of convergence and competitiveness in period 2007 - 2013 Figure 3: Consumers´ surplus

Figure 4: Producers´ surplus Figure 5: Total welfare

Figure 6: Welfare under linearity of supply and demand functions Figure 7: Comparing two different market equilibria

Figure 8: Welfare under free trade regime Figure 9: Welfare under tariff protection

Figure 10: Welfare effects of customs union for the home country Figure 11: Gains and losses in a customs union of two countries Figure 12: Welfare before redistribution takes place

Figure 13: Example of regional redistribution and resulting welfare effects Figure 14: The idea of Lorenz and Gini

Figure 15: The method of OLS

Figure 16: GDP per capita in PPS in 1995 and 2007 (%, EU – 25 = 100%) Figure 17: Change in GDP per head in PPS during 1995 - 2007

Figure 18: Development of GDP p.c. in PPS in 1995 – 2007, most developed countries (%, EU – 25 = 100%)

Figure 19: Development of GDP p.c. in PPS in 1995 – 2007, “cohesion four” (%, EU – 25 = 100%)

Figure 20: Development of GDP p.c. in PPS in 1995 – 2007, NMS – 10 (%, EU – 25 =100%) Figure 21: Development of GDP p.c. in PPS in 1995 – 2007, Bulgaria and Romania (%, EU – 25 = 100%)

Figure 22: Real GDP p.c. growth rate, average 1995 – 2006 (%, constant prices) Figure 23: GDP p.c. in PPS in regions of EU – 27 (%, EU – 25 = 100%)

Figure 24: Change in GDP p.c. in PPS in regions of EU – 27 in 1999 – 2002

Figure 25: Concentration of Community structural assistance by member state in 1989 – 1993 Figure 26: Concentration of Community structural assistance by member state in 1994 – 1999 Figure 27: Concentration of Community structural assistance by member state in 2000 – 2006 Figure 28: Concentration of Community structural assistance by member state in 2007 – 2013 Figure 29: Calculation of the size of redistribution

Figure 30: Real GDP growth rate in EU – 25 (%) - average 2000 – 2006

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1. INTRODUCTION

The European Union counts itself to the richest parts of the world, is acting as a unified sovereign entity and has power of an internal market and human potential of about a half of a billion citizens. According to the World Bank data, the EU is the wealthiest world area. In 2006, EU – 25 produced roughly 30% of total world GDP.

Simultaneously, the Community is not pretty homogeneous: there are substantial internal income disparities among its regions. This issue has become the main concern of my master thesis. These disparities were twice as great in EU – 25, with its 254 regions, than they were in EU – 15, and it is crucial to stress that these differences occur both between and within individual member states.

There exist numerous literatures on the issue of regional problematic. First let’s mention neo – classical or convergence school of thought which argues that the regional problem is not a problem at all: free movement of goods, services and production factors would, under certain assumptions, equalise factor earnings and living standards in all the regions within the integrated European area. Just the Rome Treaty was based on the notion of real convergence via market integration.

However, even laissez – faire governments may be tempted to intervene in the economy as the adjustment process is working so slowly that it is not politically acceptable. Moreover, such a “classic” premise has not passed the test of time.

Another stream, divergence school of thought, has on the other hand emphasised growing disparities rather than equalisation among regions. Imperfect markets with economies of scale, constrained mobility of factors, transport costs, externalities etc. might increase attractiveness of already advanced areas, trigger agglomeration tendencies and widen regional gaps rather than reduce them.

Case of the EU lies somewhere between, but not directly on any of these two counterparts.

Income gaps within the Community remain significant, more notably at regional than at national level, they have further increased account on the Eastern enlargement, process of convergence has been several times aggravated by economic crises and the true is even that the problem has been exacerbated by intensive growth in core regions, but disparities have been rather stabilised, range of less developed regions have approached their socio – economic features to the EU average and in general, there have been tendencies to gradual, though slow convergence. Structural and Cohesion funds have responded to this situation and seek to help regions to exploit advantages of market integration better.

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Regional problematic is a very large topic for which there are numerous empirical studies and theoretical models discussing impacts of regional policies on cohesion and convergence.

As e.g. Zahradník (2003) illustrates, most of them confirm positive, but uncertain effects;

convergence has reached only a limited level, in both GDP p.c. differences and employment/unemployment rates. Fries (1998) speaks about a tangible influence on the least favoured member states, but also he states that the development depends on both internal and external factors in all countries and regions, which are frequently much more important than the use of public funds. Also Pelkmans (1997) summarises that contribution of Structural funds to real convergence has been considerable in “cohesion countries”, at least at macro – level, that there are economic forces moving the EU towards interregional convergence, but that the pattern and stability are unreliable. Given persisting inequalities, it is hardly surprising that doubtable long - run trends fail to convince the EU political leaders to leave it to free market processes.

Main purpose of this thesis is to provide with some important facts about the institutional structure and development of the EU regional policy, to explain how it works and what is hidden behind this idea of structural redistribution, to show the development of income disparities within Europe over period of approximately last twenty years and to suggest what has been the role of RP in this development: whether structural policies have contributed to cohesion as considered in form of relative income gaps or not. I find this issue to be highly interesting, because while being the second biggest budget article, RP absorbs huge amount of funds, over the observed period money devoted to regional problematic has more than tripled and of course the following question arises: isn’t it only a waste of source?

Chapter 2 describes historical development of RP, mentions basic justifications for its existence and introduces its main principles, priorities, financial instruments and recent challenges. Programming periods 1989 – 1993 and 1994 – 1999 are handled relatively briefly at this place; greater space is devoted to periods 2000 – 2006 and 2007 – 2013, which already regard more to our country.

Because cohesion policy is a policy of redistribution, it causes changes of welfare in concerned areas. Chapter 3 provides with such a concept of welfare, discusses possible welfare effects of economic integration and shows that from regional redistribution both subsidising and subsidised regions can earn profits.

Chapter 4 offers a methodological background for application chapters 5 and 6. Its content is created by methods of measurement of income gaps (attention is paid to GDP per capita in PPS related to the Union average, Lorenz curves, Gini index and standard deviation), by

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explanation of the notion of linear regression, by discussion about significance and goodness of fit of a model and by defining concrete models for regional disparities.

Chapter 5 deals with income disparities in the EU and with their development over time, both at national and regional levels, whether they have narrowed or have not, and considers averaged GDP per head in PPP, real GDP p.c. growth rates, Gini indexes, weighted standard deviations and shares of population living below the poverty line. Also it mentions general economic development in the Union, because overall economic prosperity might be of considerable importance for achieving cohesion. Finally, by the means of Gini coefficients and Lorenz curves I tried to evaluate redistributive effects of the EU regional expenditures, in terms of the extent to which they have been aimed at weaker rather than richer parts of the Community.

In chapter 6 I present some empirical studies on effectiveness of RP, which have been developed by economic authorities, but at the same time I choose my own approach to regional problematic. On the basis of models for regional disparities defined in chapter 4 I try to show, whether there has been a positive rather than negligible or negative relationship between the EU structural resources and reducing of averaged income gaps across the Union.

Most of the studies handle in the first place “cohesion four”, but I try to explore RP effects both for particular EU countries and for the EU as a whole. As in most of existing models and simulations, also my analysis is concerned by macroeconomic effectiveness of assigned funds; at micro – levels, studies are hard to come by. Chapter 7 concludes and interprets the obtained results.

Although all models are essentially wrong and should be used with caution, they can at least suggest some results and challenges. If some countries are pumped by relatively high amounts of resources in comparison to others, but regional disparities do not tend to decline there, it might declare something about the effectiveness of use of Structural and Cohesion funds in those areas.

Main trouble of the regional issue is that this redistribution is heavily politicised and sensitive. In addition, regional policy in its current form is a relatively young question.

Therefore: first, the data we are provided with do not constitute a sufficiently long time line and the models thus cannot serve as an implicitly reliable and mistake – free instrument.

Second, for most areas no complete information on the locations of structural resources by regions is freely accessible. In more ideal case, analysis using data on particular European regions would be carried out, but due to the above mentioned difficulties I had to manage this puzzle with data on individual national economies.

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2. REGIONAL POLICY – WHAT IS IT ABOUT?

2.1. DEVELOPMENT AND JUSTIFICATION FOR EXISTENCE OF THE EU REGIONAL POLICY

At the very beginning of the European integration, there were no substantial disparities among members of the European Communities, therefore there was no significant interest in pursuing of common regional policy; period till the seventies was characterised by trust in free market and free trade. The Regional Policy Directorate – General, a coordination body of joint regional policy, was established in 1968. Idea of regional policy implemented at the Community level was born; the main reason was decrease in economic dynamics in that period and entrance of countries, which were economically less developed (Ireland in 1973, Greece in 1981 and Portugal and Spain in 1985) or which suffered from fundamental internal inequalities (UK in 1973).¹

Precise basis for the European regional policy as such was laid by the Single European Act (1986); the agreement specified main RP principles² and set aim at reducing of negative impact of single European market especially on countries of Southern Europe and other disabled regions.³ In 1988, RP was integrated with a part of agricultural and social policy into so called structural policy, i.e. policy of social and economic cohesion. Cohesion as one of the main EU goals was defined in the Treaty of Maastricht (1993) and further.

“The Union shall set itself in the following objectives: to promote economic and social progress and a high level of employment and to achieve balanced and sustainable development, in particular through the creation of an area without internal frontiers, through the strengthening of economic and social cohesion...”

Treaty on the EU, Article 2⁴

Today regional policy counts itself to the most important EU policies; in period 2000 – 2006, with the sum of about € 235 billion it represented more than two thirds of the EU budgetary expenditures and it was the second biggest budget article. The main task of RP is to

1 Due to this reason, UK tends to be identified as “the birthplace” of regional policy.

2 See below.

3 In that period, there were structural difficulties in regions of UK, France, Belgium and Italy – serious problems of traditional industries.

4 Treaty of Maastricht coincides with the Treaty on the EU. In: http://www.evropska-unie.cz.

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transfer resources from richer to poorer regions. It is both an instrument of financial solidarity and economic rationality, and consequently a powerful force for further economic integration.

Behind the statement of solidarity, under the idea of “people’s Europe”, one can find policy goal to benefit citizens and areas that are economically and socially disadvantaged in comparison to the EU average levels. Increasing pace of globalisation and technological change offer new opportunities and present new challenges. At the same time, however, Europeans do not all have the same advantages in face of those developments, depending on whether they live in a region that is prosperous or lagging behind, a dynamic or depressed area, a city or countryside, an isolated locality or one of the key economic Union centres etc.

“Solidarity is a basic value of the Union.”

Contribution of Commissioner for Regional Policy Danuta Hübner, International Conference

‘The Conditions of European Solidarity’, Vienna, November 6-7, 2004

Economic integration results in both costs and benefits. Total effect of integration should be positive, otherwise there would be no incentives to participate in this process. Empirical studies more or less support presence of these positive effects. But despite the optimistic total outcome, some participants are gaining, while the others are loosing. Redistribution of benefits between primary winners and losers is then an economically rational action motivating all players to participate in the integration process. Here we have the second justification for existence of RP: it is an economic necessity and rational behaviour of all involved subjects. Details of this point are closely discussed in chapter 3.

Finally, because the EU presents itself and often operates as a single entity, excess non - homogeneity and deep disparities with inside may have a negative impact on economic dynamics and growth of the whole Union. Abstractedly speaking, narrowing of the income gaps between poorer areas and those who are better off might be in effect beneficial for the Union as a whole, it might increase the growth potential of European economy to common benefit of all its parts. Concentration of economic activity in economic centres might lead to higher efficiency of production in the EU in shorter time horizon. However, the same concentration is able to inhibit competitiveness of the Community in the long – run by restricting ability of weaker regions to use their comparative advantages and thus it might deteriorate their production potential. In addition, concentration of economic activity and population in such a restricted area of the Union could have adverse effects also on the central regions, where it is responsible for traffic congestion and strong pressure on the environment.

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“...in order to promote its overall harmonious development, the Community shall develop and pursue its actions leading to the strengthening of its economic and social cohesion...The Community shall aim at reducing disparities between the levels of development of the various regions and the backwardness of the least favoured regions...”

Treaty on the EU, Article 158⁵

2.2. REGIONAL POLICY PRINCIPLES

European regional policy is based on five main principles:

1) Programming, i.e. creating of plans for longer – term horizons. Programme documents have the following structure: framework strategy for cohesion policy defining common principles, national development plans and particular operational programmes. This principle supports certainty and stability of the system, however it might be burdening as well, with excessive complexity, unsatisfactory flexibility and often time – consuming planning.

Moreover, it takes some time until structural expenditures start to be beneficial and undertaken investment come back in form of boosted growth and increased cohesion.

2) Concentration. It ensures that most resources go to regions that are most in need. In programming period 1994 – 1999, structural aid went to regions covering 50% of the EU population; during 2000 – 2006 this share was further reduced to 40%. Concentration of the largest amount of funds to the weakest areas enables realising of smaller number of bigger projects; limited resources have to be concentrated on a limited number of problems. Their total effect is then greater, more visible and easier to monitor.

Table 1 shows percentages of national population in particular countries of EU – 27 covered by financial assistance under Objective I during 1989 – 2006 and under priority of convergence in 2007 – 2013. Applying of the principle of concentration is evident: share of population eligible for support under these objectives has declined in relatively more developed states and on the other hand resources have been more intensively targeted at weaker areas. As we will see many times below, Objective I and convergence have been helping the relatively least developed European regions and have taken most of the EU disposable funds. Statistical phasing – out is part of the convergence priority and covers regions under transitional support with lost eligibility caused by the EU enlargement.⁶

5 In: Third Report on Economic and Social Cohesion (2004).

6 In those regions, averaged GDP p.c. is only slightly above the threshold of 75% on the ground of the statistical effect of the enlarged Union.

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Table 1: % of national population assisted by Objective I and by priority of convergence in particular RP programming periods

country Objective 1 1989 - 93

Objective 1 1994 - 99

Objective I 2000 - 6

convergence (including phasing – out)

2007 - 13

phasing - out 2007 - 13

Belgium 0 12,8 12,6 12,4 12,4

Denmark 0 0 0 0 0

Germany 0 20,6 16,4 18,5 6,1 Greece 100 100 100 92,2 55,6 Spain 57,7 59,7 57,5 37 5,8

France 2,7 4,4 2,9 2,9 0

Ireland 100 100 26,6 0 0

Italy 36,4 36,7 33 30,2 1

Luxemb. 0 0 0 0 0

Netherlands 0 1,5 1,8 0 0

Austria - 3,7 3,4 3,4 3,4

Portugal 100 100 65,8 71,6 3,8

Finland - 0 19,9 0 0

Sweden - 0 4,9 0 0

UK 2,8 5,9 8,4 4,6 0,6

Czech Rep. 88,6 88,6 0

Estonia 100 100 0

Hungary 100 72,1 0

Cyprus 0 0 0

Latvia 100 100 0

Lithuania 100 100 0

Malta 100 100 0

Poland 100 100 0

Slovenia 100 100 0

Slovakia 88,9 88,9 0

Bulgaria 100 0

Romania

They were not yet members of the EU in that

period.

Not

members. 100 0

Source: Eurostat. In: First Cohesion Report (1996) and Regional Policy Inforegio web sites.

3) Partnership – active cooperation between the Commission and individual member states and particular organisations (public institutions, private companies, social partners etc.) according to the principle of subsidiarity.⁷ Mutual cooperation enhances better targeting of RP projects, on contrary it might be followed by excess administration.

4) Additionality – EU policies and resources strengthen, not fully supplement, national ones. So the Structural funds add to, rather than substitute for, national efforts to promote economic and social cohesion.

5) Monitoring, control and evaluation at all stages of the process (ex ante – basis for the creation of development plans, quantification of objectives; on – going – during the period; ex post – conclusions and consequences for RP).

7 The subsidiarity principle ought to ensure that decisions are taken as closely as possible to the citizen.

Therefore the Union does not take action (except in the areas which fall within its exclusive competence) unless it is more effective than action taken at national, regional or local level.

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2.3. PERIODS 1989 – 1993 AND 1994 - 1999

Period 1989 – 1993 is referred to as the first RP programming period. The European Council in Brussels in February 1988 overhauled the operation of Solidarity (nowadays Structural) funds and for 1989 – 1993 allocated around ECU 68 billion to them. The amount of that time transfers almost doubled and Structural funds became the main instrument to achieve cohesion. 52% of resources came to European Regional and Development Fund (ERDF), 31% to European Social Fund (ESF) and 17% to European Agriculture Guidance and Guarantee Fund (EAGGF). Nearly 8% of funds was taken by Community initiatives,⁸ 1%

was designed for innovative actions and technical aid and the whole rest to Objectives 1, 2, 3, 4, 5a and 5b.⁹

For the following period, 1994 – 1999, more than ECU 150 billion was available from the Community’s budget for structural policies. It represented about a third of total Community spending and 0, 45% of Community GDP. Further boost to regional transfers as a means to promote cohesion followed from the Maastricht Treaty. 90% of total finance was decided upon at the initiative of individual member states, 9% was reserved for Community initiatives¹⁰ and 1% for technical assistance and innovative measures. 47% of resources were allocated to ERDF, 30% to ESF, 13% to EAGGF, 1, 5% to Financial Instrument for Fisheries Guidance (FIFG) and 8, 5% to Cohesion fund.

There were four regional priorities accounting for 85% of funding: Objective 1, 2, 5b and 6. Three other priorities (15% of resources) applied Community – wide, having no geographical limitations: Objective 3, 4 and 5a.

• Objective 1 (nearly 70% of total financial means) – helping regions whose development was lagging behind.

• Objective 2 (11%) – adjustment of regions seriously affected by industrial decline.

• Objective 3 (9, 5%) – fight against long – term unemployment and unemployment of the youth.

8 Such as ENVIREG (problems of environment), INTERREG, REGEN (international and interregional cooperation), RESIDER (adjustment in steel industry), RENAVAL (shipbuilding), RECHAR (coal - mining), RETEX (textiles), KONVER (defence), STRIDE, TELEMATIQUE, PRISMA (promotion of innovative capacity and development of smaller - size enterprises), LEADER (development of rural areas), NOW and HORIZON (integration on labour market).

9 Details about funds, initiatives and objectives are discussed below.

10 INTERREG, REGEN, LEADER, REGIS, EMPLOY (full participation on labour market), ADAPT

(adaptation to industrial change), RECHAR, RESIDER, RETEX, KONVER, SME (development of small – and medium – size enterprises), URBAN (development of urban areas), PESCA (support to fisheries sector) and PEACE (peace and reconciliation in Northern Ireland).

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• Objective 4 (1, 6%) – preventive measures to adaptation of workers to industrial change.

• Objective 5a (4, 4%) – adjustment in agriculture and fisheries sectors.

• Objective 5b (4%) – structural adjustment in rural areas.

• Objective 6 (0, 5%) – tackling problems of sparsely populated areas (some regions in Finland and Sweden).

2.4. PERIOD 2000 - 2006

In period 2000 – 2006, € 213 billion (195 billion for Structural funds and 18 billion for Cohesion fund) was embarked for structural instruments for EU – 15. In addition, about € 22 billion in pre – accession aid¹¹ and another € 22 billion in structural interventions for new EU member states in period 2004 – 2006 was spent within the EU adjusted financial perspectives.¹² Total sum of € 235 billion (i.e. total structural aid without the pre – accession aid) represented nearly 34% of the EU budgetary expenditures.

For 2000 – 2006, there were again three basic forms of regional aid: national initiatives (94%), Community initiatives (5%) and innovative actions (1%). The rule was that the income of each EU member state from structural operations must not exceed 4% of its GDP.

National initiatives constituted initiatives of individual member states and were realised on the basis of particular national development plans. In comparison to previous programming periods their number was lowered; they were divided into Objective I – III:

• Objective I. It assisted to economic development of the least advantaged regions.

These regions are according to NUTS II administration¹³ defined as areas with GDP per head in purchasing power standards (PPS) during last three years lower than 75%

of the EU average. This objective charged nearly 70% of overall resources and took support by all four Structural funds.

11 Phare - € 10, 92 billion – strengthening of economic and social cohesion and administrative and institutional capacity; ISPA - € 7, 28 billion – projects in the field of transport and environment, preparation for Cohesion fund; SAPARD - € 3, 64 billion – agriculture and rural development.

12 Ten new EU member states were eligible for assistance from Structural funds and Cohesion fund from May 1, 2004. Period 2004 – 2006 may be regarded as transitional, allowing the new members to prepare ground for next, longer programming periods.

13 Nomenclature of Territorial Units for Statistics; a legal framework for geographical division of the EU territory in order to harmonise collection, transmission and publication of national and Community statistics. At this level eligibility for structural aid is determined.

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• Objective II. It supported regions facing structural difficulties (e.g. high unemployment levels, declining industries), took about 11, 5% of resources and support by ERDF, ESF and FIFG.

• Objective III. It was promoting development of human capital, employment and modernisation of educational and training systems. It consumed about 12, 5% of funds and subvention by ESF.

Objectives I and II were regional, they excluded each other: either the region was eligible for Structural funds support under Objective I or Objective II, but not under both of them. By contrast, Objective III was horizontal; it covered the whole Union except for the Objective I regions, where measures for education, training and employment were included in the catch – up programmes.

Picture 1 shows individual zones of EU – 25 according to their eligibility for financial support under Objectives I and II in period 2000 – 2006. Objective I covered in particular that time new EU member states, Portugal, Spain, Greece, Southern Italy and a few regions in Ireland, Great Britain, Germany and Scandinavia. It is interesting to note that among NMS – 10, only Prague and Cyprus were under Objective II and not I. Prague is the richest region among CEECs; its GDP p.c. is now approaching to 140% of the EU – 25 average.

Figure 1: Regions in EU – 25 under Objective I and II in period 2000 – 2006

Source: http://www.strukturalni-fondy.cz.

Objective I Objective II Transitional

support (till 31/12/2005)

Objective II (partly) Transitional

support (till 31/12/2006)

Transitional support (till 31/12/2005) Special

program

Transitional support (partly, till 31/12/2006) EU candidate states

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Community initiatives covered the whole Union and aimed at finding solutions to problems common to a number of or even all member states and regions. First motion always arose on the part of the Commission and then negotiation with a MS followed. Community initiatives are, in general, interested in areas which otherwise tend to be insufficiently emphasised in the programmes. In 2000 – 2006, these initiatives were in comparison to previous programming periods lowered to four and encompassed the following:

• INTERREG III – development of cross – border, international and interregional cooperation. This initiative was financed by ERDF.

• URBAN II – development of cities and urban neighbourhoods, which was financed by ERDF as well.

• LEADER+ - promotion of rural development, which was supported by EAGGF.

• EQUAL – fight against discrimination on labour market, support to equal opportunities. This initiative was funded by ESF.

Innovative actions and technical aid laid in exclusive power of the Commission and made up from pilot projects and studies. Regional innovation strategies (RIS) were intended as a response to the need of businesses, specifically SME’s, to innovate. RIS produced quite significant results in form of creation of new regional partnerships and joint working methods, strengthening of innovative process and launching of new innovation projects within firms.

2.5. FINANCIAL INSTRUMENTS

Financial instruments serving to purposes of RP have been especially four Structural funds (ERDF, ESF, EAGGF and FIFG; in period 2000 – 2006 they covered about 86% of total resources), Cohesion fund (9%) and European Investment Bank. EIB advances loans especially for infrastructure (more than 80%) and building. Main advantages of those loans are “marginal” interest rates. Both the EIB and the Cohesion fund are based on a project financing approach and are governed by their own specific rules.

European Regional and Development Fund was established in 1975 and it is the biggest Structural fund and basic instrument of the EU structural policy. During 2000 – 2006 it took hold of more than 60% of RP resources. It provides funds for investment into infrastructure, SME’s, environment, health, education, R&D etc. European Social Fund was set up by the Treaty of Rome and its main fields of interest are fight against unemployment, human resources, integration on labour market, equal opportunities, education, adaptation of labour

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force to changes etc. European Agriculture Guidance and Guarantee Fund was set up in 1968, but only the guidance section was included to the system of Structural funds. It fosters modernisation and structural development in agriculture. Financial Instrument for Fisheries Guidance was established in 1993, but under Structural funds it has gone since 2000. It provides support to fisheries industry (common fisheries policy).

Cohesion fund came into operation in 1993 and localises itself in concrete projects concerning environment and transport infrastructure. Resources are destined for particular countries, not for separate regions. To become eligible for support from Cohesion fund, member states must have GNP p.c. in PPS < 90% of the EU average. Eligible countries were so called “cohesion – four”¹⁴ before the Eastern enlargement; since 2004 Greece, Portugal, Spain and NMS – 10; since January 2007 Bulgaria and Romania have joined.

2.6. PERIOD 2007 - 2013

In current programming period, 2007 – 2013, as a reaction on hitherto situation, European regional policy is passing through several changes and this reform results into, we can say,

“new architecture of cohesion policy.” There are four main challenges for RP to be met: issue of the enlargement, more balanced development, Lisbon strategy and a new partnership for cohesion.

As it was already mentioned above, the enlargement of 2004 has led to widening of socio – economic development gap and a geographical shift in the problem of disparities to the East.

In 2004, GDP of newcomers varied from about 80% of the EU average in Cyprus to less than 50% in the Baltic States. GDP of Bulgaria and Romania is fairly below 40% of the Union average.

Promotion of a well - balanced development is closely connected to the first challenge.

More equable development may be reached particularly through greater concentration and well – targeted investment. FDI, a substantial factor in regional development, bring transfers of technology, skills, tacit knowledge and governance, which might generate spillovers to domestic economies and contribute to cohesion. The problem is that FDI have tendency to concentrate themselves in more developed areas, they are not necessarily attracted into

14 “Cohesion – four” denoted Spain, Portugal, Greece and Ireland. The Commission deemed Ireland as ineligible (with GNP of 101% of the average) under the Cohesion fund as of January 1, 2004.

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regions that are most in need.¹⁵ Instead, they tend to go disproportionately to stronger rather than weaker parts of the Union and to concentrate around large cities. According to the Czech Statistical Office, in 2000 – 2003 foreign investment which came to Prague reached roughly one half of total financial resources coming to the Czech Republic from abroad in that period.

Third Report on Cohesion states that in the second half of the nineties, more than 60% of the total going to Slovakia went to the Bratislava region and that the Tallinn area accounted for more than 80% of FDI going to Estonia. Further, Döhrn (2001) mentions examples of Latvia, Lithuania and Hungary, where FDI in 1999 coming to capital regions formed 57%, 52% and 64% of total FDI, respectively. Döhrn´s analyses also confirm that FDI, although their overall results are positive, favour capitals and border regions and therefore might increase internal income differences and have a negative impact on regional cohesion.

In March 2000 at the meeting in Lisbon, the Council set out a strategy designed to “make Europe the most competitive and dynamic knowledge – based economy in the world by the year 2010.” The Gothenburg Council in June 2001 completed this strategy by linking it with sustainable development. Cohesion policy needs to incorporate the Lisbon objectives and to become one of the key instruments for their development via national and regional programmes. For new generation of RP programmes, the Commission has proposed a strong aim at growth and jobs.

Creation of a new partnership for cohesion means greater transparency, efficiency and political accountability. This requires especially a clear definition of a strategic approach for the policy, setting out its main priorities, ensuring coordination of all concerned subjects and allowing for a regular, open review of progress made.

In February 2004, the Commission presented three main priorities of the reformed RP – “A New Partnership for Cohesion: Convergence, Competitiveness and Cooperation.” Final form of financial perspective for 2007 – 13 was adopted on the summit of the Council on December 16, 2005. In comparison to the previous period, overall EU budget as well as the amount of structural expenditures was increased: the whole budget composes from about € 862, 4 billion, which is 1, 045% of the EU gross national income. More than one third of this amount comes to RP (36%, roughly € 308 billion). From that EU – 15 obtain 51, 7% of resources, while new member states including Bulgaria and Romania 48, 3%. Concerning particular priorities, convergence uses 81, 9% of resources, competitiveness 15, 7% and cooperation 2, 4%.

15 Investors take into account such factors as accessibility, infrastructure deficiencies, lack of a skilled workforce and all that.

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Priority of convergence is important especially in CEECs and encompasses support to economic development, employment growth and job creation in the least developed EU regions.¹⁶ Concretely, devoted resources promote modernisation of economic structure throughout the EU, improvement of infrastructures, environmental protection, investment to human capital, education and quality of labour market institutions and adaptation and enhancement of administrative capacities. These targets are financed by ERDF, ESF and Cohesion fund.

To strengthen competitiveness, attractiveness as well as employment of regions there are regional programmes to anticipate and encourage positive change in industrial, urban and rural areas. The Union intervenes in particular in fields of knowledge society, environmental protection including prevention of risks and support for Lisbon strategy. This objective is financed by ERDF and ESF and supports regions that are not under the objective of convergence.

Figure 2: Regions under priorities of convergence and competitiveness in period 2007 - 2013

Source: http://ec.europa.eu/regional_policy.

16 These regions are defined as areas with GDP p.c. during last three years lower than 75% of the EU average, distant regions (e.g. Madeira), and for actions of Cohesion fund with GNP p.c. lower than 90% of the EU average.

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The objective of European territorial cooperation takes resources from ERDF and comes mainly from the former initiative INTERREG – support for further integration and reduction of social and economic fragmentation generated by national frontiers by the means of cross – border (77%), international (19%) and interregional (4%) cooperation. This priority has been always typical for the Communities. Its main aim is to ensure harmonious and balanced development throughout the whole EU and it concentrates especially on international knowledge exchange, R&D and informational society.

Figure 2 illustrates particular European regions according to their eligibility for support under priorities of convergence and competitiveness. Convergence comes from the former Objective I. This priority, which takes most of the available resources, covers especially new EU members, Southern parts of Portugal, Spain, Italy and Greece and a few parts of Germany, Belgium and UK. Among EU – 15, no resources at all go to convergence in Denmark, Ireland, Luxembourg, Netherlands, Finland and Sweden. Regional competitiveness and employment puts together previous Objective II and III. Among new member countries, no resources at all go to competitiveness in the three Baltic States, Malta, Poland, Slovenia, Bulgaria and Romania. Priority of cooperation, which accrued from former Community initiatives, covers the whole Union, all the twenty seven countries.

Table 2: Comparison of main priorities and financial instruments of cohesion policy in current and previous programming period

2000 - 2006 2007 - 2013

priorities financial instruments priorities financial instruments Cohesion fund Cohesion fund

Objective I

ERDF ESF EAGGF FIFG

Convergence

Cohesion fund ERDF

ESF

Objective II ERDF ESF Objective III ESF

Regional competitiveness and employment

ERDF ESF INTERREG III ERDF

URBAN II ERDF

EQUAL ESF LEADER+ EAGGF

European territorial cooperation

ERDF

Rural development and fisheries industry except for the framework of Objective 1

EAGGF FIFG

The issue falls no more within cohesion policy; it belongs to CAP.

9 PRIORITIES 6 INSTRUMENTS 3 PRIORITIES 3 INSTRUMENTS Source: http://www.strukturalni-fondy.cz.

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Table 2 compares priorities and financial instruments of RP in periods 2000 – 2006 and 2007 – 2013. We can take a notice of process simplification: former nine priorities were integrated into three and only three financial instruments (ERDF, ESF and Cohesion fund) are now being used for RP purposes. Importance of Cohesion fund increases; it was earmarked roughly 20% of the total allocation for RP instruments (€ 63 billion).¹⁷ In a nutshell, new programming period tries to simplify procedures and make them decentralised, more transparent and effective. Old and new EU members will no longer be treated separately and funding will be concentrated on those regions of the twenty seven member states that are most in need.

3. ECONOMICS OF REGIONAL REDISTRIBUTION AND WELFARE ECONOMICS

Because structural policy is transferring resources between particular regions, it naturally leads to changes in welfare in those areas. The notion of welfare does not have any unambiguous definition; we may understand it as good fortune, health, happiness, prosperity, quality of life and all that. But economists like to have things measurable; therefore we will take welfare as utility of market players expressed in money. We will distinguish between the welfare of consumers and of producers. Concept of welfare is being frequently used in analysis of various trade arrangements and accordingly of economic integration effects; see e.g. Lipsey (1960), Hansen – Nielsen (1997) or Turnovec (2003).

3.1. CONCEPT OF WELFARE

As it was suggested above, to be able to evaluate and compare effects of different positions of a country/region in an international division of production factors, we need an indicator to assess quality of changes that are in question. Therefore economic theory provides us with a

17 In period 2000 – 2006 it was about 10%, € 27 billion.

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concept of welfare. Economic welfare, divided into consumers´ and producers´ surplus, was contributed by Alfred Marshall; therefore these two components of welfare are sometimes described as “Marshallian surplus.” He originally used this idea to rigorously analyse the effects of taxes and price shifts on market welfare.¹⁸

Figure 3: Consumers´ surplus

Source: Lectures to the course EM081 Advanced Economics of European Integration - Microeconomic Aspects at IES, Charles University. Available at: http://ies.fsv.cuni.cz.

Let’s assume the simplest possible market for only one commodity, demand for that commodity q = D(p) as a decreasing function of its price p, supply q = S(p) as an increasing function of the price, conversely. The economy is closed, no trade is assumed. Intersection of demand and supply functions defines an equilibrium point ^E ^≡

[

^q^∗^;^p^∗

]

^; i.e. the point where market is cleared and there is no excess supply and demand, quantity demanded is just equal to quantity supplied.

Measure of consumers´ welfare, utility of consumers in a given market situation with respect to the commodity in question, is here given by so called consumers´ surplus (CS): the difference between what consumers are ready to pay for quantity q^∗on imperfect market and what they are really paying in equilibrium E. Measure of producers´ welfare, gain of producers in the given market situation, is producers´ surplus (PS): the difference between for how much producers are ready to produce q^∗ and how much they are actually getting in equilibrium E. Total society welfare is then formed by the sum of consumers´ and producers´

surpluses: TW = CS + PS.

18 In: Marshall (1920).

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Figure 4: Producers´ surplus

Source: Lectures to the course EM081 AEEI. Available at: http://ies.fsv.cuni.cz.

Figure 5: Total welfare

Provided that both demand and supply are continuously differentiable functions, we can get CS and PS by the means of integrals: if we find a function e(q) such that

), ) (

( D q

dq q

de = where D(q) is an inverse demand function, then

; )

0 ( ) ( )

(

0

∗

∗ = − −

−

=

∫

∗

q p e q e q p dq q D CS

q

and if we find a function h(q) such that ),

) (

( S q

dq q

dh = where S(q) is an inverse supply function, then

).

0 ( ) ( )

(

0

h q h q p dq q S q p PS

q

+

−

=

−

= ^∗ ^∗

∫

^∗ ^∗ ^∗

∗

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Figure 6: Welfare under linearity of supply and demand functions

If supply and demand functions are linear, which is the case I will assume for further welfare considerations, calculation is much simpler. Let S(p)=−a₀ +a₁p and

, )

(p b₀ b₁p

D = − a₀,a₁,b₀,b₁〉0. Point A in the chart corresponds to the price of zero supply and is calculated from the equation

1

0 0

)

( a

p a p

S = ⇒ ^A = , and point B corresponds to the price of zero demand and is calculated from ( ) 0 .

1 0

b p b p

D = ⇒ ^B = Equilibrium price p^∗ comes from D(p^∗)=S(p^∗) and it holds that .

1 1

0 0

b a

b p a

+

= +

∗ Equilibrium quantity is given by ).

( )

( ^∗ ^∗

∗ = D p =S p

q Consumers´ surplus (area of the triangle BEp^∗) is then defined by

∗

− ∗

= p p q

CS ( ^B )

2

1 and producers´ surplus (area of the triangle p^∗EA) by

. ) 2(

1 _∗ _∗

−

= p p q

PS ^A ( ) .

2

1 _∗

−

= +

=CS PS p p q

TW ^B ^A

To compare two different market situations, we can say: the higher CS the better for consumers, the higher PS the better for producers and the higher TW the better for the community as a whole. Figure 7 illustrates two equilibrium positions E1 and E2, which provide different values of welfare. E2 seems to be superior to E1, because total consumers´

and producers´ surplus in E2 is greater than in E1; welfare increases. Changes leading to the switch of market situation similarly to from E1 to E2 have positive effects on welfare.

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Figure 7: Comparing two different market equilibria

3.2. WELFARE IN INTERNATIONAL ECONOMIC COOPERATION

Changes in regimes of international trade and economic cooperation, inclusive of various forms of economic integration, might affect equilibrium positions on markets. Different arrangements of international economic relations might have different effects on different national economies and their regions and different sectors in each national economy. To evaluate economic implications and desirability of those changes, it is possible to use the above discussed welfare measures and to consider the welfare effects. Arrangements increasing welfare are then assessed as economically positive and desirable, and arrangements decreasing welfare as economically negative/undesirable.

3.2.1. Welfare effects of free trade

First let’s assume the case of free trade and compare it with a closed economy. Partial market for one commodity in a small economy is considered, transportation costs are neglected. Closed economy equilibrium is EC with corresponding price p^∗_C and quantity q_C^∗. Under free trade regime, import/export of a given country represents only a very small

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fraction of the demand/supply on the world market, hence the country is a price – taker and is not able to influence the world price.¹⁹

If the world price p_W^∗ is lower than domestic price and free trade is allowed, market supply curve modifies from SD(p) to SW(p), equilibrium shifts from EC to EW, equilibrium domestic supply decreases (point C in the picture) and demand expands and the difference between them is formed by imports from the rest of the world. Consumers are gaining due to cheaper imports from abroad, market price goes down, but producers are loosing, because they are attacked by lower – cost competition from abroad. Total society welfare increases, however, and is represented by the triangle CE_CE_W.

If p_W^∗ is higher than p_C^∗, free trade regime reduces domestic demand and increases domestic supply and the difference between them is exported on the world market.

Consumers are loosing due to higher market price, but producers are gaining. Total welfare gain is again positive.

Figure 8: Welfare under free trade regime

In both cases, free trade increases total community welfare. But its implementation has always conflicting character - some social groups are gaining, while the others are loosing: if the world price is lower than closed equilibrium price, free trade leads to consumers´ gain and

19 We can say that the world supply/demand function is perfectly price elastic.

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producers´ loss, and if the world price is higher than domestic price, consumers are losers and producers winners. That is one of the reasons why it would be so complicated to introduce free trade as a general regime of international economic relations among particular world economies, although it brings positive welfare effects. From the short – run, static equilibrium point of view, there would be always social groups and strong lobbies advocating protectionism and opposing policies of free trade.

Looking for other alternatives and trade – offs, national governments use numerous kinds of trade protection measures: import tariffs, export duties, import quotas, export incentives etc. Next sub – chapter discusses case of an import tariff and compares the resulting welfare changes with closed economy and free trade regime. Again the simplest assumptions are taken into account: partial market for only one commodity, small economy in price – taking position, no transportation costs.

3.2.2. Welfare effects of tariff protection

Let the import tariff be defined as a certain extra value t imposed on the world price. If we assume ,p_W^∗ 〈 p_W^∗ +t〈p_C^∗ we reach tariff equilibrium of Et. Market price is lower than original domestic price and higher than the world price, domestic demand increases in comparison to closed economy case and decreases in comparison to the regime of free trade, domestic supply is higher than under free trade regime and lower than under no trade. Tariff protection naturally reduces imports from abroad and so benefits domestic producers.

Consumers´ surplus is given by the area of the triangleBp_W^∗ +tE_t, producers´ surplus by .

tCA

p_W^∗ + In addition, there are government revenues generated by the tariff: RSEtC. Total welfare in tariff equilibrium is greater than in closed equilibrium, but smaller than under free trade regime. So introducing import tariff, there is a welfare reduction in comparison to the free trade case. In the chart, this welfare loss is represented by triangles DRC and SEWEt. It is the loss of consumers´ surplus caused by the increase in market price. Tariffs have a redistributive function; part of consumers´ surplus lost due to imposing tariff is further used through the public budget (for provision of public goods, social transfers etc.)

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Figure 9: Welfare under tariff protection

3.3. INTEGRATION AND DISTRIBUTION OF COSTS AND BENEFITS

To explain welfare effects of economic integration, let’s consider a simple model of a customs union, Viner´s model.²⁰ Under the term “customs union” we understand a group of countries that agree to remove all visible trade restrictions (such as tariffs and quotas) and to apply a common level of protection against goods coming from the third countries (i.e. they adopt a common external tariff). Although reality is much more complex, I am using this simplest case just to illustrate that taking part in a form of economic integration may be beneficial for a country. Naturally, more advanced integration forms than customs union (such as common market, monetary, economic or even political union), large number of players and multi – commodity analysis could be included and price – taking assumption removed, but their detailed explanation goes far beyond the purpose of this thesis.

Any economic theory of regional integration should address the question of economic justification of particular integration forms – whether an arrangement would be superior to the status quo or not. Contribution of Jacob Viner in this field was an introduction of welfare considerations into the theory of international trade. Positive and desirable welfare change, so called trade creation, is caused by the replacement of higher – cost domestic production and/or imports by lower – cost imports. On the other hand, trade diversion is a negative welfare change due to the replacement of imports from a low – cost source by imports from a

20 See e.g. Boltho (1982).

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higher – cost source.²¹ Economic integration is justified, if it leads to a trade creation, because in this case it increases efficiency and welfare.

Basic assumptions of Viner´s model are as follows: perfect competition, perfect factor mobility within individual countries, perfectly price elastic world supply, no economies of scale, no transportation costs, three participants – the world market and two countries discriminating against the rest of the world, one commodity, customs union formation does not increase the level of tariff protection.

3.3.1. Welfare effects of customs union

Figure 10: Welfare effects of customs union for the home country

There is country H (home country), assumed to be small, and country P (potential partner), assumed to be big. Let’s discuss welfare effects of customs union for country H. H is not able to influence price. If pw < pp < pw + t < pH, under tariff protection H covers part of its domestic demand by import from the world market. After customs union with P is created, trade within the union is tariff – free, for the market price of pp = pcu, which is lower than pw + t. As a result, domestic supply decreases and demand as well as imports expand. In comparison to tariff protection, decrease of equilibrium price leads to increase in consumers´ surplus by areas a, b, c and d in the chart, producers´ surplus decreases by area a and government looses

21 Original Viner´s definitions were trade creation as a switch in trade from more expensive to less expensive producers and trade diversion as a switch in trade from less expensive to more expensive producers.

MASTER THESIS

CHARLES UNIVERSITY IN PRAGUE Faculty of Social Sciences

Institute of Economic Studies

MASTER THESIS

2007 Bc. Lucie Svrčková

Charles University in Prague Faculty of Social Sciences

Institute of Economic Studies

MASTER THESIS

European Cohesion Policy: Did It Succeed in Lowering of Regional Disparities?

ABSTRACT

ABSTRAKT

CONTENTS

LIST OF TABLES

LIST OF FIGURES

1. INTRODUCTION

2. REGIONAL POLICY – WHAT IS IT ABOUT?

2.1. DEVELOPMENT AND JUSTIFICATION FOR EXISTENCE OF THE EU REGIONAL POLICY

2.2. REGIONAL POLICY PRINCIPLES

2.3. PERIODS 1989 – 1993 AND 1994 - 1999

2.4. PERIOD 2000 - 2006

2.5. FINANCIAL INSTRUMENTS

2.6. PERIOD 2007 - 2013

3. ECONOMICS OF REGIONAL REDISTRIBUTION AND WELFARE ECONOMICS

3.1. CONCEPT OF WELFARE

[

]

∫

∫

3.2. WELFARE IN INTERNATIONAL ECONOMIC COOPERATION

3.3. INTEGRATION AND DISTRIBUTION OF COSTS AND BENEFITS